Dollar Ready to Rebound?

The dollar has spent most of the last year in a breathtaking tailspin, driving commodity prices through the roof, increasing the cost of imports, and raising inflationary pressure on consumers. Some relief may finally be around the corner, however, argues Paul LaMonica at CNN.

Most economists believe that the Fed is swiftly approaching the conclusion of its rate cut regime, and with Europe's economy beginning to slow, interest rate differentials may soon become more favorable. LaMonica:

The market also seems to be sensing that the Federal Reserve may stop lowering interest rates soon. That would also help strengthen the dollar since big rate cuts since last September are one reason why the dollar has fallen.

"Investors are reacting to the idea that the Fed is almost done or done cutting rates," said Bill Knapp, investment strategist with MainStay Investments. "There is continued inflation pressure. That's the biggest risk to the economy and the Fed knows that."

To buy this scenario, however, you need to make a few optimistic assumptions. You have to assume the housing market and economy will stablize soonish, so as to forestall further rate cuts. You also have to assume that the European Central Bank will begin cutting rates, which may be unlikely given ECB head Jean-Claude Trichet's infamous stinginess:

...two scenarios could keep the dollar rallying. The first is that the European Central Bank, which has resisted calls for rate cuts, finally starts lowering rates. That would sap some of the euro's strength. [Economist Bill] Knapp doesn't see that happening anytime soon though.

The more likely situation, according to Knapp, is that the Fed cuts its federal funds rate to 2% at the end of this month, keeps it there for a while and then starts raising rates later this year as the economy picks up.